As reported in the Taipei Times, Economist and Ph D. Robert Shiller states that faulty models are one of the culprits that led to the lack of forecasting of the financial crisis by economists. Shiller states these models lack the study of economic bubbles necessary to prevent crashes like our recent crisis one;

“The widespread failure of economists to forecast the financial crisis that erupted last year has much to do with faulty models. This lack of sound models meant that economic policymakers and central bankers received no warning of what was to come…the current financial crisis was driven by speculative bubbles in the housing market, the stock market, energy and other commodities markets. Bubbles are caused by feedback loops: rising speculative prices encourage optimism, which encourages more buying and hence further speculative price increases — until the crash comes.”

Real estate is Cyclical, Seasonal and Emotional, and Dr. Shiller appears to believe this as well. The “faulty models” caused an emotional stir that led to speculative prices until the crash. The question is; which faulty models is Dr. Shiller referring to exactly?

Is the Case-Shiller Index included in his broad statements? Some economists argue that Case-Shiller is one of the faulty models that contributed to the increasing optimism and rising speculative prices in the market; as well as the panic and fear when the markets began to decline. (Case-Shiller articles).

Developed in the 1980’s, the Case-Shiller Index evaluates trend changes in housing prices on a monthly basis of homes being purchased. The index appears to be limited in the data it considers and analyzes, disregarding specific property data elements that assessment offices began to collect after its creation. Basic property data collected from public records such as school districts, location factors, square footage, age of home, land area, garages, bathrooms, views, waterfront, public amenities such as water/sewer and other property structures appear to have limited influence in the calculations of the index.

For example, does the index adjust for the increased average size of a home built after 1995? Using the same brush from 1980 and repainting over the same picture causes one to have an obscure view of a localized market like real estate. In recent Index reports, Case-Shiller has inaccurately weighted metro areas suffering more foreclosures, which drag down the overall value of the Index. Yet, it remains the leading index in the market; unaltered, unaccounted and underperforming during our most recent crashes.

Dr. Shiller’s Index lacks the very ‘sound’ that he rebukes in his own article.

So can we expect an overhaul of the Case-Shiller Index? Hindsight is always 20/20, and this article sounds more like a promotional piece promoting his latest books, than an honest challenge to fellow economists to revise models and develop more reliable measurement tools for the future.

When Dr. Shiller sold the Case-Shiller Index in 2001, what were the terms of the sale? Did the conglomerate he sold to make adjustments to the index? And the final question, what benefit did the conglomerate gain by having S&P promote the index starting in 2005?

Hopefully Dr. Shiller is taking his own advice and examining the fundamentals of the Case-Shiller Home Price Index and seeking ways to improve on a model, that when developed was the only one of its kind. Today, many economists and computer technicians have access to so much data, that more complex models offer better solutions with limited influence from corporate rating organizations.

The latest news on property data and Home Prices should not come as a surprise and we should not begin celebrating an end to the crisis. In our article Cyclical, Seasonal and Emotional, we discussed the three critical phases of real estate selling patterns that have attributed to the housing bust.

The latest news and public records indicate that these critical phases are performing to historical levels. That is, the summer seasonal market is showing a correction to the cyclical change that began in 2007. Now the million dollar question is, will the fall seasonal market (which affects Florida, Arizona and Nevada) continue to show recovery or will the markets pause until the next “Selling Season in 2010?”

Our report: Housing in Crisis(published in March 2009) addressed the broader issue of excess housing. Again, there is good news on this front. The excess housing is being absorbed at an annualized rate of about 1 million units. Having a glut of 5 million units at the end of 2008, this means we have another three to four years before the overall markets start to recover.

Housing Recovery is the focal point here. We predict that the Northeast will continue to show stability, with modest corrections in local markets from 3% to 5% through the end of 2010. The Midwest remains strong and will experience similar stability. In the five biggest areas where excess housing still dictates selling patterns, we are predicting that Arizona will recover sooner than sections of Florida and Vegas.

The latest news on the housing market is not a surpirse. Recovery and Stability are the focal points and we should start to see signs of this in the upcoming months.

No one should be surprised when the next Housing Index comes out in September which will show a further strengthening of the market and continued adjustment in housing values in an upward trend. Our report Median Sales Price published in March of 2009 indicated that the overall Median Sales Price would move upward to $215,000 to $220,000 by year end. The current median sale price as reported by the Commerce Department is a $210,000, an increase of over 5% from the low of $201,400 early this year.

“The median can be a deceptive statistic when it comes to real estate growth. Often home sellers will point to an increasing median and say that homes prices are increasing, but they can actually be decreasing.” – Investor Centric

This Investor Centric article explains the deception in the median sale price and how it isn’t a true indicator of market stability. What the article does not explain is a clear way to rid the deception; price per square foot.

As shown in the chart above, the median sale price of San Bernardino County has drastically increased. That doesn’t mean that the county’s home values are plummeting necessarily. As the article states, “they just don’t have enough higher price homes to sell.”

That’s why analyzing property data on a price per square foot basis broadens the scope on particular areas of the market. Public records show that higher priced homes have more square footage generally. It can be clearly seen that by analyzing San Bernardino county solely on the median it is not doing do well.

But based on price per square foot, is the San Bernardino County market good or bad?

In a recent report by AccuriZ titled “Square Footage Matters! Large homes indicate stable values” Northeastern Queens values proved not to be declining as significantly as Queen County in its entirety. This is based on price per square footage:

Source: AccuriZ

Median Sale Price

“Analysis of the Queens County single family market have declined 18% from 2008 and 21.3% since 2006. The sub-market of Northeast Queens indicates that property values are down 12.8% since 2006, with most of the decline occurring in 2009.”

Source: AccuriZ

“A more detailed analysis of the median sale price based on the square footage of the residence indicates an entirely different pattern of price value changes. When the sales data is stratified into the calculated rate per square foot based on sale price, the rate of change for Queens County is -10.58% since 2006 versus -21.3% based on the Median Sale Price. For Northeastern Queens the rate of change is -.37% versus -12.8%. The data clearly indicates that building size represents a significant impact relating to the value of the property.” (For more of the “Square Footage Matters!” report, click here.)

With these statistics we would like to add on to the quote in the beginning, “Often economist and analyst will point to a decreasing median and say that homes prices are decreasing, but they can actually be stable.”

So realtors, what do you think? Is the median deceptive? Is it used primarily as a selling point? Or is the median a true indicator?

It can be argued that the current economic crisis was based on a number or separate but tangible factors. One argument relates to monetary policy over the past decade as being a key contributor to the downturn.

As interest rates were lowered by the Federal Reserve, borrowed money became increasingly easier to obtain. This enabled a broad range of economic growth to occur, one of which was new housing.

New housing starts are influenced and regulated by local governments who must issue permits for construction. The lack of checks and balances from local government to police the growth fueled the rapid growth of development. Some actually argue that local government was more concerned about increasing tax revenue, then being concerned about over development.

Source: Census Bureau ; News N Economics

In the chart above first reported by News N Economics, the housing bubble is clearly identified as beginning in 2003 continuing to 2006, reaching a climax of over 3.3 million housing starts. As interest rates were lowered after September 11 2001, contractors and developers borrowed without many limitations; the focus being to maintain growth, not stabilize it. New homeowners were able to borrow without the strict regulatory policies of the past and 4 million renters became owners.

So the question remains, did standards get lowered so the excess housing stock could be absorbed? There is antidotal evidence to support this claim and perhaps the simple answer is an analysis of the current foreclosure market. The current level of foreclosure is comprised of many of the first time home buyers and mostly in homes built in the past seven years.

Had this been regulated, would the economic crisis be as bad as it is? If housing construction was controlled and home ownership more tightly regulated, foreclosures, vacancies, distressed mortgages etc. might have been easier to absorb.

Fraud and bad debt were the offsets of a lenient monetary policy, but we believe that if one variable – the boom in housing starts – was controlled significantly, the economic bust would not have been as severe.

The question now is how do we learn from this continuing cycle, and prevent it from occurring once again in future? While interest rates were low at the start of the housing boom, mortgages rates have presently been at record lows. When the excess construction has been absorbed and values have hit bottom, what will be the outcome be?

The answer was to lower the ownership standards and permit those who could not afford home ownership the ability to do so with No-doc, No Asset verification loans. Home ownership is based on decades of proven lending standards since the Great Depression. So, did we lower standards to meet demand or were standards lowered to create demand? In either case, the result is the same:

Did analysts conclude that a loan made to an unqualified buyer at a lower loan amount would be offset by a quality loan from a qualified owner? Did 3.5 million new home buyers in the market cause a “bubble”? Did developers, who needed new home buyers to stimulate the housing market ignore supply and demand factors out of greed or just bad analysis? And finally were new communities in warmer climates, notably Florida developed to attract those preparing for retirement or did an influx in migration cause development?

According to public records and property data, there is no less than 4 million excess residential units in the United States, of this over 70% are single family properties. Given current population growth estimates and natural building activity needs, an absorption cycle of no less than three years will be needed before the housing industry experiences a significant increase in housing starts and achieves development of over 1 million units per annum.

“What I notice is that the sales pair counts are becoming increasingly weighted toward the biggest bubble – i.e., foreclosure – metro areas: LA, San Diego, Phoenix, etc. Sales in these areas are really dragging down the overall value of the index. Presumably, the foreclosure sales are weighted less heavily, but it is somewhat suspect to me that the share of Phoenix’s housing market, for example, has increased its share of pair counts by 8.7% over its sample average, 5.4%.”

In her July 2 article, Rebecca discusses the S&P Case-Shiller index and how it could be potentially creating a foreclosure bias when weighting its 20 city index.

Thank you, thank you!

We have been analyzing the Case Shiller data for years and as you have indicated very concisely, the index does have a potential for bias.

Your direct comment about Phoenix and Arizona hits the mark. Case Shiller refers to the overall sales price and does not consider the fundamentals of the sale price such as square footage, age of home and land area. Nor, in our opinion does it recognize the weight of the general population size to sales activity size.

Based on property data and public records, our analysis indicates that the price decline, if developed on a sales price per square foot basis, is not as drastic. Furthermore if you establish a weighting influence for the impact of foreclosures, the decline would be even less.

Maricopa County (Phoenix) had a study completed to determine the influence of foreclosures for assessment purposes. This report clearly shows a differential of 10% to 15% (depending on level of foreclosures). This report is based on the sales price per square foot. So if 1.5 million homes in the 5th largest city are valued recognizing these influences, why isn’t Case Shiller recognizing this.

Many will argue that foreclosures are market value and hence are the market. In my opinion this is not true. Yes foreclosures influence the market, but adjustments must be considered for these sales under market conditions and financing in an appraisal.

In addition to your comments on all of the regions, I will clearly state this: More weight should be developed based on the general population of properties, not the sales activity alone.

Kudos’s for pointing this out. Case Shiller represents two-thirds of the housing market? Well what is it leaving out? An index that tracts Metro Market should be based on a consistent parameter (say 60 mile radius) and it should identify the total properties covered, residential properties and annual sales activity. This index should also categorize properties into groups. I find it very difficult to accept that a 1,000 square foot house has the same economic and demographic buyer as a 2,500 square foot house.

Yes, I understand the need for a general overview, but the resources exist for a more expansive index and it should be developed. This is no easy task. Our current property data tracking covers 45 million properties versus Case Shiller at 70 million. Our analysis clearly indicates that Case Shiller, while being a benchmark is not a true indicator of the overall market.

Based on this past real estate crisis, we simply cannot afford to use indexes that lack total coverage and stratification levels which will enable financial institutions, realtors, builders and the general public the ability to understand a very complex financial market.

Several recent comments regarding the availability of financing have emerged over the past weeks discussing mortgage rates and the ability to sell/buy real estate. Contrary to popular belief, mortgage rates have more to do with the long term debt obligations of the United States, than the current value of real estate. A review of 30 year T-Bills indicates a concern of investors regarding the debt the United States is taking on. This is also reflected in the value of the American dollar, which has declined over the past several months.

In regards to mortgage financing, the markets did not stop; instead the markets went back to operational practices of 2002/03. The United States housing market is on track to sell over 4 million properties this year and the mortgage industry is on track to refinance double that number of properties. This represents about 12% of the residential housing market (4% sales and 8% refinancing).

Homeowners are receiving financing, but not necessarily at the numbers they had hoped for. Secondly, public records show that property values are down because of the median sales price. The much discussed Case-Schiller Housing Index does not place a relationship of sales price to the size of the home.

Now many economists and bloggers will state that there is no relevance in Sales Price to Square Footage. Based on property data, we state that there clearly is: Square Footage does matter.

In studies just completed, 15 of 20 major metro areas have experienced a decline in sales price compared to last year and to 2006. But the properties being sold are also smaller and by as much as 15% to 20%. As such, the decline in actual value is not as severe as reports that only analyze the Median Sales Price indicate. The real estate market is not absolute. The base data from 2006 is different than the data from 2009.

So what is the real decline in housing values and what is the real erosion of the under lying housing market? Well it depends on if you do the research or if you are an investor looking to snap up properties at bargain basement prices because incorrect information is being fed to the masses.

Conducting comprehensive research takes time and money, but many of the comments I read just rip into the process, as opposed to trying to understand the process. The markets are in flux and need some clear direction, but if we continue to post inaccurate information we will not see a housing recovery take foot for months.

Yes, overall values are surely down, but based on this report and public records, building size causes a significant difference in the values being presented. What do you think about these conclusions?